Friday, May 15, 2009

Chinalco moves closer to doubling its stake in Rio Tinto

Chinalco moved a step closer to doubling its stake in Rio Tinto today when the US foreign investment regulator has given clearance for the planned $US 19.5 billion investment. The two companies released a joint statement today saying they obtained clearance from the Committee on Foreign Investment in the United States (CFIUS) for Rio to issue convertible bonds to Chinalco and also allow the Chinese company indirect minority investment in Rio’s Kennecott Utah Copper Corporation, the world’s largest copper mine. The US approval follows similar approvals from the Australian Competition and Consumer Commission (ACCC) on 25 March and the German Federal Cartel Office on 31 March.

However, two important final hurdles remain: Australian foreign investment approval and approval from Rio shareholders, neither of which can be taken for granted. In March, the Foreign Investment Review Board (FIRB) requested a 90-day extension due to the deal’s complexity of the deal and the number of other applications by Chinese state-owned groups for Australian investments. Meanwhile shareholders are angry Rio is favouring Chinese money over their rights to buy more of the company's shares.

Chinalco (an acronym for the Aluminium Corporation of China Ltd) is already Rio Tinto’s largest shareholder with 9 percent of the company and the proposed deal would double their investment to 18 percent. Founded in 2001, the Chinese government majority owned company has 200,000 employees and has interests in Australia, Peru and Vietnam. On 1 February it made its bid to increase its Rio Tinto share (with US giant Alcoa putting up roughly 10 percent of the money). China watchers say the government put up the money to avoid a BHP takeover of Rio. A merged BHP/Rio would have become the largest single producer of iron ore, aluminium and other resources with immense pricing power over its Chinese customers.

However Chinalco deny this is the reason for the deal and have been keen to stress it is independent from the government. It hired public relations firm FD Third Person to address shareholder concerns about a Chinese state-owned enterprise controlling Australia’s natural resources. Their strategy has been undermined somewhat with the news chief executive Xiao Yaqing has recently taken a role with the Chinese State Council which is the de facto government cabinet.

Nationals Senator Barnaby Joyce has been in the forefront of Australian opposition to the deal. He has been seen on television advertisements in Queensland and the ACT for the last two months in what was initially a one man campaign (though South Australian independent Nick Xenophon has now joined him) against the merger. Joyce’s ads warn against “foreigners” buying "the source of [Australian] wealth" and he exhorts his audience to “stop the Rudd Government from selling Australia”. The adverts were paid for by Perth-based businessman and political activist Ian Melrose who says his motivation was annoyance about China “buying parts of Australia.” Melrose and Joyce have been backed up by an Essential research poll in March which found 57 percent of Australians were wary of Chinese investment in resource companies.

The question is whether the poll feelings are pro-Australian or merely anti-Chinese. Given that Rio Tinto is a multinational company with joint headquarters in London and Melbourne, it is debatable whether it is a truly Australian asset. The company has made fabulous profits throughout the mining boom, but it was undone in 2007 by the questionable $44 billion purchase of Canadian aluminium company Alcan which left it with substantial debts. Rio is now trying to convince investors and regulators that the accord signed in February with Chinalco is the best way to slash the company’s $38.9 billion debt mountain.

The deal is not yet set in stone. Doubts remain over the terms of the convertible bonds, which is currently worth $7.2 billion. With a recent rebound in metal prices, there is speculation Rio would change the bonds issue to make it available to all Rio shareholders (not just Chinalco) or even scrap the deal entirely and bring in another strategic investor such as rival miner BHP Billiton. Chinalco’s position is that the terms of the convertible bonds are negotiable, but the other major element of the deal ($12.3 billion in direct investments in mining assets such as Kennecott) should remain as agreed. Then assuming the shareholders can be mollified, it still needs final political approval. FIRB has until 14 June to make its recommendation on the matter to Treasurer Wayne Swan. The final decision belongs to the Australian Government.